Why is the time ripe for a revolution
in agri-value chain finance?
Lamon Rutten
CTA
Overview
• Value chain finance – why now?
• Chain-linking farmers to finance
• Forms of value chain finance
• What is need...
Value chain finance – why now?
Push ……….. and pull
•The need to secure
supply (in terms of
quality and quantity) of
the co...
The push…
0
10
20
30
40
50
60
70
80
1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050
SSA EastAfrica CentralAfrica So...
The pull...
Exchange
Investor
Farmer
Chicken
processing
plant
2. Forward contract
1. Due diligence
3. Cession of the right...
But push and pull factors only create
potential
SME financing requirement in Sub-Saharan
Africa, 2012 – appr. US$ 80-100 b...
But risk perception has to
change
A bank tends to make
only small margins on
loans. One deal that
goes bad can wipe out
th...
Is subsidizing agri-loans a solution?
No. Schemes to provide agricultural loans at subsidized
interest rates were prevalen...
Is more micro-finance a solution?
Not in its traditional form:
- group-lending and heavy monitoring is too expensive
(payi...
Bank
Borrower
Will the borrower
earn enough, and
reimburse?
Bank
Borrower
Will the borrower
be able to
perform
Risk
mitiga...
Value chains require a structuring of the link of producers to
consumer demand. Producers need to be enabled to meet
chang...
Value chain financing 
Financing the value chain
Value chain financing 
Financing the value chain
Chain-linking farmers to finance
1
2
3
Farmer produces for a
specific offtaker
Off-
taker
Farmer produces to a set
standar...
Chain-linking farmers to finance
1
2
3
Farmer produces for a
specific offtaker
Off-
taker
Farmer produces to a set
standar...
VC finance directly counters the two
main risks of agri finance
Inability to reimburse.
Agriculture is risky.
Dependency o...
Forms of VC finance
• Warehouse receipt finance (at
different parts of the chain)
• Processor-centered finance
• Financing...
Warehouse receipt finance
The concept: turn commodities into gold
Vault
Bank
Borrower
Deposit gold
in bank vault
… and get...
Warehouse receipt finance
The concept: turn commodities into gold
Vault
Bank
Borrower
Deposit gold
in bank vault
… and get...
Four possible relationships between the
bank and its “vault”
The Latin/
Turkish model
1
Banks can set up
arms-length colla...
Four possible relationships between the
bank and its “vault”
The Latin/
Turkish model
1
2 Collateral
management
Four possible relationships between the
bank and its “vault”
The Latin/
Turkish model
1
2 Collateral
management
Public
war...
Four possible relationships between the
bank and its “vault”
The Latin/
Turkish model
1
2 Collateral
management
Public
war...
Warehouse receipt finance – an
example of SME financing
Warehouse
Printer
Financier
Sale at
beginning of
school year
Conti...
Port of loading (Black Sea)
Bulky fertilizer (Beira, Dar)
Bagging
Central distribution warehouses
Distribution
warehouses,...
And an export operation…
Processor-centered value chain
finance
Smallholders
Finance the offtaker, who will take full
responsibility for the produc...
Farmers Off-
taker
Contract
Bank
Young animals
Mature animals;
milk
Veterinary
services
Assignment of
receivables, and
pay...
Off-
taker
Bank
Trader
Animals are moved to offtaker
Monitoring
agency Check the number and
weight of animals sold
Check t...
Agent
Exporter
International
Buyers
(Supermarket
chains and
Auctions)
4- Pay within 15 days
2- Issue notes for
payment in ...
Applying value chain finance to
micro-finance
Agent
bank
International
offtakers 5. Instruction to
release funds to
farmers
1.
Tripartite
agree-
ment
7. Settlement of i...
Fertilizer
company 4. Hedge
Producers
Bonded
warehouses
Borrower
(exporter)
Commodity
exchange
Standard Bank
8. Coffee
2. ...
VC finance is safe and easy
Value chains generally continue
functioning over many years. Thus,
financiers can construct
st...
What is needed to make it happen ?
• Learn from best practices
• pro-active governments and Central Banks
• supportive dev...
VC finance is not just a private
sector matter
Supportive legal/regulatory
environment
Central
Bank
support/
discount
faci...
Learn from history !
Collateral
manager
Bank
Commodity
owner
Central
Bank
Loan of X $
Documentation
Submission of the loan...
Farmer Investor
Farmer issues
a Financial
CPR, backed by cattle
Payment
Agent bank
escrow
account
Buyer
Inspection
agency
...
In conclusion...
• Value chain finance is a need of the day – a key
tool to get agriculture to meet current challenges –
b...
Go for it !
www.fin4ag.org
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Why is the time ripe for a revolution in agri value chain finance

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Presentation by Lamon Rutten (CTA) at social reporting workshop before Fin4Ag conference

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Why is the time ripe for a revolution in agri value chain finance

  1. 1. Why is the time ripe for a revolution in agri-value chain finance? Lamon Rutten CTA
  2. 2. Overview • Value chain finance – why now? • Chain-linking farmers to finance • Forms of value chain finance • What is needed to make it happen?
  3. 3. Value chain finance – why now? Push ……….. and pull •The need to secure supply (in terms of quality and quantity) of the commodities that a fast growing and increasingly competitive market requires. • Declining risk capacity • Consumers demand proper value chains • ICT makes VC finance easier • Traditional financial sector barriers are disappearing
  4. 4. The push… 0 10 20 30 40 50 60 70 80 1950 1960 1970 1980 1990 2000 2010 2020 2030 2040 2050 SSA EastAfrica CentralAfrica SouthernAfrica WestAfrica African urbanisation rates as % of total population Source: AFRACA/CTA/Ecobank, Opportunities for value chain finance in Africa’s intra-regional food trade - forthcoming
  5. 5. The pull... Exchange Investor Farmer Chicken processing plant 2. Forward contract 1. Due diligence 3. Cession of the rights to payment under the forward contract 4. Confirmation of assignment of payment 5. Repo: sale of the forward contract, with obligation to buy back after 90 days 6. Purchase of the repo (through a broker) Broker 7. Funds 8. Funds 9. Funds Capital market investors are looking for new ways to invest their funds. And they are growing in size and sophistication, including in many ACP countries.
  6. 6. But push and pull factors only create potential SME financing requirement in Sub-Saharan Africa, 2012 – appr. US$ 80-100 billion/year 23% 77% Available financing Financing gap Source: IFC. Finance for agriculture has to increase by at least half. Currently, 90% of finance going into agriculture comes from the farmers themselves. So, either farming should become much more profitable, or external financing for agriculture has to increase radically.
  7. 7. But risk perception has to change A bank tends to make only small margins on loans. One deal that goes bad can wipe out the profits of dozens of deals that went well. Thus, banks tend to stay away from deals that they perceive as risky.
  8. 8. Is subsidizing agri-loans a solution? No. Schemes to provide agricultural loans at subsidized interest rates were prevalent in the 1960s and 1970s, but they largely failed (but they still exist, in countries like the USA or Nigeria, and politicians continue asking for them). The common position now is that subsidies for agri-finance should be indirect: - To help financiers manage risks: weather risk insurance, credit guarantee schemes - To develop supportive institutional, regulatory and policy frameworks (eg, for warehouse receipt finance, investment funds) - To build capacity and improve KM.
  9. 9. Is more micro-finance a solution? Not in its traditional form: - group-lending and heavy monitoring is too expensive (paying 1% interest on a 5 day loan permitting a small- scale processing operation with a 10% profit margin looks OK; paying 40% on a 180 day loan doesn’t) - small loans and regular repayment don’t fit with the agricultural season. So, MFIs need to adapt their methods to engage in agri- finance. Eg, micro-leasing, VC finance.
  10. 10. Bank Borrower Will the borrower earn enough, and reimburse? Bank Borrower Will the borrower be able to perform Risk mitigation mechanism H o w ? From credit risk to performance risk Value chain finance permits financiers to shift their risks
  11. 11. Value chains require a structuring of the link of producers to consumer demand. Producers need to be enabled to meet changing consumer demand. A proper value chain approach therefore cannot focus exclusively on farmers. Linked to a number of global developments (sustainability, food safety, etc.), many companies have an interest in acting as enablers. In many cases, NGOs, government bodies and development agencies can be facilitators. This should give rise to a new kind of development project, including farmer-business-NGO partnerships, and PPPs. Seller Buyer Seller Buyer From supply chain….. to ….. value chain Value chain  supply chain
  12. 12. Value chain financing  Financing the value chain
  13. 13. Value chain financing  Financing the value chain
  14. 14. Chain-linking farmers to finance 1 2 3 Farmer produces for a specific offtaker Off- taker Farmer produces to a set standard and sells in such a way that his market is secure, but competitive 1 2 E.g., warehouse receipts, auctions, commodity exchanges E.g., contract farming
  15. 15. Chain-linking farmers to finance 1 2 3 Farmer produces for a specific offtaker Off- taker Farmer produces to a set standard and sells in such a way that his market is secure, but competitive 1 2 E.g., warehouse receipts, auctions, commodity exchanges E.g., contract farming
  16. 16. VC finance directly counters the two main risks of agri finance Inability to reimburse. Agriculture is risky. Dependency on weather, prices, availability of markets, condition of roads, rural insecurity… Unwillingness to reimburse. Past practices often discouraged farmers from honouring their obligations. Make sure loan is used to improve farmer’s revenue. Build risk management tools into the loan. Ensure that the reimbursement is not by the farmer, but is made through a stronger link in the value chain.
  17. 17. Forms of VC finance • Warehouse receipt finance (at different parts of the chain) • Processor-centered finance • Financing traders through the monitoring of their value chain operations • Final buyer-centered finance (eg., factoring) • Pushing pre-export finance up- country • Full supply chain financing (from inputs to final buyers)
  18. 18. Warehouse receipt finance The concept: turn commodities into gold Vault Bank Borrower Deposit gold in bank vault … and get an ‘easy’ loan Showing your wealth isn’t enough – the bank prefers to take it under its own control (to take possession).
  19. 19. Warehouse receipt finance The concept: turn commodities into gold Vault Bank Borrower Deposit gold in bank vault … and get an ‘easy’ loan “Vault” Bank Borrower Deposit commodities in bank “vault”… … and get an ‘easy’ loan
  20. 20. Four possible relationships between the bank and its “vault” The Latin/ Turkish model 1 Banks can set up arms-length collateral management subsidiaries. Still prevalent in Latin America and Turkey; was once quite important in the US.
  21. 21. Four possible relationships between the bank and its “vault” The Latin/ Turkish model 1 2 Collateral management
  22. 22. Four possible relationships between the bank and its “vault” The Latin/ Turkish model 1 2 Collateral management Public warehousing 3
  23. 23. Four possible relationships between the bank and its “vault” The Latin/ Turkish model 1 2 Collateral management Public warehousing 3 The Indian model: collateral manager takes over warehouses for use as public warehouses 4
  24. 24. Warehouse receipt finance – an example of SME financing Warehouse Printer Financier Sale at beginning of school year Continuous printing of books during the year Schools Paper supplier Collateral manager Working capital finance Payment of invoices Reporting Control Delivery of paper (imported) Weekly releases of paper
  25. 25. Port of loading (Black Sea) Bulky fertilizer (Beira, Dar) Bagging Central distribution warehouses Distribution warehouses, Zambia Distribution warehouses, Malawi Buyers trucktruck truck train train trucktruck vessel truck Financing of an import operation, e.g. fertilizers – the bank starts with control over the goods as they are being loaded, and then retains control as they move down nearer to the buyers. Goods are only released from the warehouses once the bank has received an appropriate payment or guarantee. The advantages of this are two-fold. International finance (at low cost) can be brought to the buyer’s factory gate; and large, cost-efficient volumes can be combined with low working capital needs for the buyers. An import financing using collateral management
  26. 26. And an export operation…
  27. 27. Processor-centered value chain finance Smallholders Finance the offtaker, who will take full responsibility for the production process… Off- taker Contract Bank Young animals; veterinary services Mature animals; milk For example, contract farming…
  28. 28. Farmers Off- taker Contract Bank Young animals Mature animals; milk Veterinary services Assignment of receivables, and payment Contract Insurance ContractDue diligence Processor-centered value chain finance (a more complex form) Funding
  29. 29. Off- taker Bank Trader Animals are moved to offtaker Monitoring agency Check the number and weight of animals sold Check the number and weight of animals bought Assignment of receivables, and payment Loan Spot checks Financing traders by monitoring their value chain operations
  30. 30. Agent Exporter International Buyers (Supermarket chains and Auctions) 4- Pay within 15 days 2- Issue notes for payment in 30 days 1- Export merchandise 3 (a)- Issue new notes with payment in 90 days INNOFIN 3 (b)- Pay immediate cash at a discount 5- Pay back after 90 days Afreximbank FinanceAgreement Leveraging on the buyers… starting with factoring
  31. 31. Applying value chain finance to micro-finance
  32. 32. Agent bank International offtakers 5. Instruction to release funds to farmers 1. Tripartite agree- ment 7. Settlement of invoice values ITFC Transit depots 6. Release of funds to farmers’ cooperatives 4. Verify and submit documents received 8. Final reimbursement Facility manager 1* 3d# * Sales contracts, letters of assignment of export proceeds, letter of guarantee by Gambia government. # Copies of invoices. 3b. Transportation to final depot 3f. Shipping and shipping documents Export depot GGC 3e. Monitoring (quality, quantity) 3c. Warehouse receipts 3a. Warehouse receipts 2. Delivery Groundnut farmers’ cooperatives Pushing pre-export finance up the chain
  33. 33. Fertilizer company 4. Hedge Producers Bonded warehouses Borrower (exporter) Commodity exchange Standard Bank 8. Coffee 2. CPRs 3. CPRs 7. Payment 1. Fertilizer 5a. Assignment of CPRs; assignment over hedge proceeds; warrants at bonded warehouse. 6. Loan 5b. Performance guarantee on producers delivering against the CPRs. Full supply chain financing
  34. 34. VC finance is safe and easy Value chains generally continue functioning over many years. Thus, financiers can construct standardized financing mechanisms, where the “entry” of the commodity into one particular phase of the chain is sufficient to trigger the financing.
  35. 35. What is needed to make it happen ? • Learn from best practices • pro-active governments and Central Banks • supportive development partners
  36. 36. VC finance is not just a private sector matter Supportive legal/regulatory environment Central Bank support/ discount facilities Support institutions that mitigate risks Central Banks played a central role in developing agricultural finance in 19th and early 20th century Europe and USA… providing good models for today’s developing country Central Banks and Ministries of Finance.
  37. 37. Learn from history ! Collateral manager Bank Commodity owner Central Bank Loan of X $ Documentation Submission of the loan of X $, with documentary proof that it is a proper warehouse receipt loan, for discounting Loan of X $, at the official discount rate In 1848, the Bank of France created 49 "bonded warehouses", which started to provide companies with warehouse warrants for various; sub-discount banks also set up by the Central Bank accepted these warrants as collateral, and their loans constituted discountable paper for the Bank of France.
  38. 38. Farmer Investor Farmer issues a Financial CPR, backed by cattle Payment Agent bank escrow account Buyer Inspection agency Reporting monitoring Payment Payment Assignment Contract Delivery Commodity exchange Price risk management CPRRegistrar Registration ICTs facilitate institution-building ICT-enabled
  39. 39. In conclusion... • Value chain finance is a need of the day – a key tool to get agriculture to meet current challenges – but also, a great opportunity for banks. • But mindsets have to change and skillsets need to improve. • Governments should take their responsibilities… but not fall back in the failed 1960/70s model in state-driven subsidized credit. • Development partners can provide support in several ways, from capacity- and institution-building to the provision of risk capacity.
  40. 40. Go for it ! www.fin4ag.org
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